Dynamic Dependency between the Shariah and Traditional Stock Markets: Diversification Opportunities during the COVID-19 and Global Financial Crisis (GFC) Periods

Abstract

The aim of the present research is to highlight whether there exist any diversification opportunities from investing in developed and developing countries’ Shariah-compliant and non-Shariah-compliant stock markets during global financial crisis (GFC) and the COVID-19 pandemic periods. For this purpose, we employ daily data for both Shariah and non-Shariah indices from 29 October 2007 to 31 December 2021. The study uses multivariate GARCH-DCC and wavelet approaches to examine if there exist diversification opportunities in the selected markets. Evidence from this study shows that although the developing markets’ stock returns experience high volatility of a similar degree, the conventional indices of Malaysia have the highest volatility among them. This shows that Shariah indices have less exposure to risk and higher possibilities of diversification compared to their conventional counterparts. Regarding developed markets, the Japanese conventional index and the U.S. Shariah indices are more volatile compared to other indices in the market. Moreover, the results of the wavelet power spectrum show significant and higher volatility during the COVID-19 pandemic rather than the GFC. Similarly, the Chinese conventional market experienced minimum variance during the GFC and COVID-19 pandemic period. On the other hand, the results of wavelet-coherence transform indicate that the Japanese Shariah-based market offered better portfolio opportunities for U.S. traders during the GFC and the COVID-19 pandemic periods. Hence, opportunities for investment in this selected market are basically close to zero. Therefore, investors should carefully choose which stocks they can include in their investment portfolio.